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International Games with National Rules: Competition for Comparative Regulatory Advantage in Telecommunications and Financial Services

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International Games with National Rules: Competition for Comparative Regulatory Advantage in Telecommunications and Financial Services International Games with National Rules: Competition for Comparative Regulatory Advantage in Telecommunications and Financial Services Steven K. Vogel Working Paper 88 June 1996 Steven K. Vogel is Assistant Professor of Government at Harvard University. The author would like to thank Michael Borrus, Joel West and John Zysman for helpful comments on an earlier draft, and Alexis Martinez for valuable research assistance. Generous support for this publication has been provided by the Alfred P. Sloan Foundation. INTRODUCTION Commentators from the popular press to business reviews have gleefully heralded the advent of "globalization," yet few offer a clear sense of what this actually means. For many authors, globalization implies a triumph of international markets over national governments: the sheer force of these international markets overwhelms national regulators, while mobile multinationals simply outrun them.1 Yet in some of the most global of industries, such as telecommunications and finance, international competition remains powerfully conditioned by national regulation. Markets in these sectors have become more global in the sense that technology has reduced the costs of international transactions, cross-border flows of goods and money have expanded, and national markets have become more integrated with international markets.2 But these markets remain governed primarily by national rules: that is, the fortunes of "global" firms remain tied to home-country regulation, host-country regulation, and the interaction of the two. Furthermore, the mismatch between international markets and national regulation has some rather profound implications for competition within these markets. With multiple national regulators governing international markets, the regulators themselves come to compete.3 But where does this competition between regulators lead us? Two prevalent schools of thought suggest contradictory answers. On the one hand, works on comparative economic systems imply that differences in regulatory regime may increasingly determine the winners and losers within the global marketplace.4 As nations reduce the most overt forms of industrial protection and 1 Kenichi Ohmae, The Borderless World: Power and Strategy in the Interlinked Economy (New York: Harper Business, 1990); Richard B. McKenzie and Dwight R. Lee, Quicksilver Capital: How the Rapid Movement of Wealth Has Changed the World (New York: Free Press, 1991); Walter B. Wriston, The Twilight of Sovereignty: How the Information Revolution is Transforming Our World (New York: Scribner's, 1992); Richard O’Brien, Global Financial Integration: The End of Geography (London: Royal Institute of International Affairs, 1992). 2 For evidence of internationalization, see Helen V. Milner and Robert O. Keohane, eds., Internationalization and Domestic Politics (Cambridge: Cambridge University Press, 1996). 3 On regulatory competition in general, see Joel P. Trachtman, “International Regulatory Competition, Externalization, and Jurisdiction,” Harvard International Law Journal 34 (Winter 1993), pp. 47-104, and Dale D. Murphy, “Open Economies” Competition for Comparative Regulatory Advantage, paper for the Harvard-MIT Seminar on International Security, November 1993; for economic analysis of its costs and benefits, see Wallace E. Oates and Robert M. Schwab, “Economic Competition Among Jurisdictions: Efficiency Enhancing or Distortion Inducing?,” Journal of Public Economics 35 (1988), pp. 333-54, and Jeanne-Mey Sun and Jacques Pelkmans, “Regulatory Competition in the Single Market,” Journal of Common Market Studies 33 (March 1995), pp. 67-89. 4 Michael Porter, The Competitive Advantage of Nations (New York: The Free Press, 1990), Eisuke Sakakibara, Beyond Capitalism: the Japanese Model of Market Economics (Lanham, MD: University Press of America, 1993), Lester Thurow, Head to Head: the Coming Economic Battle Among Japan, Europe, and America (New York: Warner Books, 1993), and Michel Albert, Capitalism vs. Capitalism: How America’s Obsession with Individual promotion, domestic regulatory systems become an even more critical element in the competitive advantage of national firms.5 In this view, national authorities engage in a competition in regulatory subsidy (or competitive reregulation): that is, they compete to design regulatory systems that favor their own firms.6 They may do so either by trying to lower the regulatory burden on domestic firms, or by trying to rig regulations to favor domestic firms (strategic reregulation).7 Over time, this competition is likely to produce a stalemate as national authorities engage in a zero-sum game in which their respective regulatory subsidies roughly offset each other. On the other hand, those more enamored with the benefits of globalization suggest that the very competition between regulators may erode differences between national regulatory regimes, rendering them obsolete as a source of comparative advantage.8 These authors stress that in a world of international markets governed by national regulations, corporations can engage in regulatory arbitrage: that is, they can shift their capital or their business activity to jurisdictions with a lighter regulatory burden. As a result, national authorities compete to design regulations to attract capital and business activity, and to prevent their flight, and this generally means reducing the regulatory burden. They engage in a competition in regulatory laxity (or competitive deregulation). Therefore, the competitive dynamic between regulators is fueling a global wave of deregulation, producing a convergence toward a more liberal regulatory model.9 Achievement and Short-Term Profit Has Led It to the Brink of Collapse (New York: Four Walls Eight Windows, 1993). 5 Trachtman, “International Regulatory Competition,” pp. 52-53. 6 Paul Krugman has written a provocative critique of the very notion of national “competitiveness in Competitiveness: A Dangerous Obsession,” Foreign Affairs 73 (March-April 1994), pp. 28-44. For present purposes, I simply note that while perhaps national authorities should be less obsessed with ‘competing’ with each other, the reality is that they think in these terms and will continue to do so for the foreseeable future. For rebuttals to Krugman’s argument, see Foreign Affairs 73 (July-August 1994), pp. 186-97. 7 The concept of strategic reregulation first appeared in Michael Borrus, Franois Bar, Patrick Cogez, Anne Brit Thoresen, Ibrahim Warde, and Aki Yoshikawa, Telecommunications Development in Comparative Perspective: the New Telecommunications in Europe, Japan and the U.S., Berkeley Roundtable on the International Economy (BRIE) Working Paper No. 14 (May 1985). For an interesting case study from the electric utility industry, see Peter Navarro, “Creating and Destroying Comparative Advantage: the Role of Regulation in International Trade,” Journal of Comparative Economics 13 (1989), pp. 205-26. 8 McKenzie and Lee, Quicksilver Capital, Wriston, Twilight of Sovereignty. 9 Philip G. Cerny, “The Dynamics of Financial Globalization: Technology, Market Structure, and Policy Response,” Policy Sciences 27 (1994); Alfred C. Aman, Jr., “A Global Perspective on Current Regulatory Reforms: Rejection, Relocation, or Reinvention?,” Indiana Journal of Global Legal Studies 2 (1995), pp. 429-64. In this paper, I test these two models of regulatory competition by looking at telecommunications and finance--the two sectors most strongly associated with "globalization."10 I compare and contrast regulatory reforms in Britain and Japan in order to determine whether national authorities are competing in a strategic game of regulatory subsidy or regulatory laxity, or some combination of the two, and to ascertain how this game is playing out over time. TELECOMMUNICATIONS Throughout the industrialized world, the traditional telecommunications regime incorporated several fundamental principles. First, telecommunications was a "natural monopoly," meaning that economies of scale were so great that a single operator could provide service more efficiently than two or more competing operators. Second, the government, whether as the regulator or as the operator itself, should insure that the telecommunications sector serves the public interest broadly defined. In practical terms, this meant that the telecommunications operator should provide universal service at a uniform price irrespective of geographical variations in the cost of providing the service. Third, the telecommunications system should be managed as a single integrated network in order to maintain uniform technical standards and to maximize interconnection--that is, to ensure that any telephone would be able to connect to any other. Among the many technological changes that have transformed the sector, three were particularly critical: the development of advanced terminal equipment, the advent of microwave and satellite transmission, and the creation of sophisticated "value-added" services combining data processing with communications. New possibilities for terminal equipment made it increasingly difficult for a single operator to provide the full range of equipment that users required. Electronics firms wanted to be able to provide terminal equipment, and users wanted the opportunity to buy this equipment. New transmission technologies provided an even more fundamental challenge because they offered a means of contesting the monopoly in basic telephone service. Corporations could bypass the monopoly carrier by creating their own private lines
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